SEC Becomes Defendant in NFT Classification Lawsuit

Law professor and filmmaker Brian Frye and songwriter Jonathon Mann have filed a lawsuit against the U.S. Securities and Exchange Commission.

Lawyers argue that DRY This approach to regulation threatens the livelihoods of artists and creators experimenting with NFTs.

What the trial says

According to the documentThe plaintiffs want to determine whether NFT falls under the regulator’s purview. Lawyers have asked the SEC to address actions that could lead to the application of securities laws to create and sell NFTs. The lawsuit also seeks information about the registration of NFTs before they can be sold.

“Two recent administrative actions initiated by the SEC suggest that the SEC is interfering in the art industry, determining when a work of art must be registered with the federal government before it can be sold.”

The authors of the paper compared non-fungible tokens to Taylor Swift concert tickets, which are often resold on the secondary market. Mann and Frye are in exactly the same situation in this lawsuit. The lawyers argue that it would be absurd for the SEC to classify these tickets or collectibles as securities:

“They are artists and they want to create and sell their digital art, without the SEC investigating them or taking legal action.”

SEC Files First Lawsuit Against NFTs

In 2021, media company Impact Theory launched the Founder’s Keys NFT collection. The company promoted the project from October to December 2021. The collection included tokens of three different rarity levels.

As a result, in August 2023, the SEC accused Theory of the impact of promoting securities without registration. The company used NFTs to attract investors, raising about $30 million. This was the first case brought by the regulator against NFTs.

The SEC believes that the company positioned the project as a business investment. In particular, it guaranteed holders high profits and promised broad prospects.

Thus, the regulator considered that the specified NFTs had the characteristics of an investment contract and, therefore, were classified as securities. By promoting the collection, the company violated federal laws in this sector.

Impact Theory agreed to pay a $6.1 million fine without admitting or denying guilt. In addition, they decided to destroy the tokens and their mentions on websites and social media.

What is considered a security according to the SEC?

Commodity futures trading Commission considers cryptocurrency as a commodity. The regulator proposes to apply the tax regime developed for property to cryptocurrency and to treat the actions of issuers as producers of goods. However, there is no rule in the United States that would require issuers to register tokens as property.

When assessing the status of cryptocurrencies, the SEC uses the Howey test.

The regulator considers that the new financial instrument has security features and considers that the cryptocurrency falls within its legislative scope.

According to the SEC, all tokens, in one way or another, meet several criteria designated by the agency: pre-sale or fundraising, promises of improving the project through continued business development and marketing, and the use of social media to demonstrate the project’s capabilities and benefits.

However, no arbitration body has been able to resolve the dispute between two US regulators, so each agency is working according to its own vision of the situation.

Traders Are Losing Interest in NFTs, Regulators Are

Despite regulators’ interest in non-fungible tokens, the excitement around NFTs continues to decline. For example, in July, the sales volume in the NFT sector amounted to $395.5 million, according to CryptoSlam. This is a new low since November 2023.

The NFT industry has been on a downward trend for a long time. Sales volume and the number of unique buyers and sellers have been steadily declining since March 2024.

Source: CryptoSlam

Additionally, sales volume fell 45% in the second quarter of 2024 compared to the first quarter, to $2.2 billion from $4.1 billion.

The decline in July began in the middle of the month. At the same time, in early July, signs of recovery in sales volume appeared after a significant decline in June. At the same time, July became the third largest month in terms of transaction volume in 2023.

During this period, 9.9 million transactions were recorded, compared to 5.7 million in June. However, this can hardly be a positive sign since the average sale price in July hit a new low since September 2023, at $39.56.

What threatens NFTs: the SEC or a drop in interest

According to the latest lawsuit filed against the SEC, the status of non-fungible tokens remains to be determined. However, the regulator is seeing less interest in this area due to the waning enthusiasm around NFTs.

Either way, the SEC’s regulatory approach threatens NFTs, which were initially conceived as a creative outlet in the broader blockchain and cryptocurrency space.

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